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Euro Closes Week on Low Note – ECB’s Bluff Called?

Euro Closes Week on Low Note – ECB’s Bluff Called?

Christopher Vecchio, CFA, Senior Strategist
Euro_Closes_Week_on_Low_Note__ECBs_Bluff_Called_body_CVEURO.jpg, Euro Closes Week on Low Note – ECB’s Bluff Called?

Euro Closes Week on Low Note – ECB’s Bluff Called?

Fundamental Forecast for US Dollar: Neutral

The Euro was one of the worst performing currencies this past week, only outpacing the lowly Japanese Yen by +0.45%, while shedding a modest -0.86% against the top Canadian Dollar, and -0.78% against the reinvigorated US Dollar. Indeed, this was a week of consolidation in FX markets; on the Euro’s side, data was mixed overall, and the same can be said about the European Central Bank’s policy meeting this week. Due to the light, but saturated docket this week, we will focus on these two issues, and why they lead us to a neutral bias for the Euro for the coming week.

The important data last week – the final releases of the February Services PMIs for Germany, France, Italy, and the broader Euro-zone; and the January Euro-zone Retail Sales report – came in higher than forecasted, alleviating some of the near-term steep recession concerns that proliferated throughout the month of February. Athough the peripheral economies, now including France, continue to head towards a sustained period of weaker growth, the prior week’s data, in context of the forthcoming week’s data, suggests that the fundamentals will be a non-factor for now.

Over the coming week, the only data that truly might have an impact are the final February German Consumer Price Index and the February Euro-zone Consumer Price Index. As has been the case for the past several months, price pressures continue to fall, suggesting that aggregate demand remains weak. In normal times, weak CPI data out of Germany and the broader Euro-zone would stoke speculation that the ECB could cut its key interest rate; but we now know after ECB President Mario Draghi’s press conference on Thursday, that a rate cut is unlikely at the next meeting in April.

Although the ECB downgraded the region’s growth forecasts for 2013 to -0.9% to -0.1%, and for 2014 to 0.0% to +2.0%, and despite the fact that the inflation forecasts were downgraded for 2013 to +1.2% to +2.0%, and for 2014 to +0.6% to +2.0% (all yearly rates), President Draghi said that “later in 2013 economic activity should gradually recover.” Is this a case of ‘do as I say, not as I do’? It is very contradictory for President Draghi to make such remarks despite a policy shift that would lead one to believe that a rate cut is around the corner (side note: the market seemed to take the forecasts then remarks in this fashion as well: the Euro sold-off on the revised growth forecasts then rallied after President Draghi’s remarks).

Furthermore, President Draghi said that the “prevailing consensus was to leave the rates unchanged,” but by Friday, with the Euro closing near it’s weekly lows, market participants may be signaling that they disagree. Thus: if the ECB is leaving rates unchanged; and President Draghi is expecting a recovery later in 2013; and the Euro is depreciating; and Italian yields are holding lower despite the likelihood of new elections that could yield a victory for populist, anti-austerity candidates; we must suggest that the ECB is close to activating its OMT program. Why would the Euro fall on this being priced in? The Euro’s strength in January 2013 was derived from the ECB’s shrinking balance sheet; if the balance sheet now expands, the Euro should lose value henceforth.

Until the ECB’s OMT program is used for Italy, we must take President Draghi’s hopes for an economic recovery later in the year in stride. The coming week should be interesting to see if market participants embrace the ECB’s view, or if the ECB’s bluff is called, and a weaker Euro will emerge as a result. –CV

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